Financial Restructuring Practice Group
March 21, 2016
Seventh Circuit Holds That Termination of a Commercial
Lease Prior to Tenant’s Bankruptcy May be an “Avoidable
Transfer”
On March 11, 2016, the US Court of Appeals for the Seventh Circuit (the
“Court”) ruled that a termination of lease that occurred prior to the tenant’s
bankruptcy may be an “avoidable transfer” under title 11 of the United States
Code (the “Bankruptcy Code”), thereby allowing the bankruptcy estate to
recover the value of the lease from the landlord. 1
Background and Applicable Statutes
Prior to filing bankruptcy, Great Lakes Quick Lube LP (the “Debtor”) leased
more than 100 oil-change stores. Two of those leases were with T.D.
Investments I, LLP (the “Landlord”). Fifty-two days before it filed
bankruptcy, the Debtor agreed with the Landlord to terminate the two leases
early, even though the leased stores were profitable.
After the Debtor filed bankruptcy, a committee was appointed to represent the
unsecured creditors of the Debtor (the “Committee”). The Committee
sought to recover the value of the terminated leases, asserting that the
termination was avoidable under the Bankruptcy Code as either a preferential
or a “constructive” fraudulent transfer and that the value of the leases should
be available to the Debtor’s creditors.
For more information, contact:
Sarah R. Borders
+1 404 572 3596
[email protected]
Elizabeth C. Tramm
+1 404 572 2813
[email protected]
King & Spalding
Atlanta
1180 Peachtree Street, NE
Atlanta, Georgia 30309-3521
Tel: +1 404 572 4600
Fax: +1 404 572 5100
www.kslaw.com
Section 547(b) of the Bankruptcy Code forbids “preferential transfers” by
debtors. Generally speaking, a “preferential transfer” is a transfer made by an
insolvent debtor within ninety days before filing bankruptcy to a creditor (in
this case the Landlord) for a debt that gave the creditor more than if it had
waited for the debtor’s assets to be distributed in the bankruptcy proceeding. 2
Similarly, section 548(a)(1)(B) of the Bankruptcy Code prohibits
“constructive” fraudulent transfers, which include transfers made by an
insolvent (or nearly insolvent) debtor to anyone within two years before the
bankruptcy that gave the debtor less than what it transferred. A trustee (or in
this case an unsecured creditors committee) may seek to avoid these types of
transfer and, thereby, recover property of the bankruptcy estate.
The Court’s Reversal of the Bankruptcy Court’s Decision
The Bankruptcy Court ruled in favor of the Landlord, concluding that the
termination of leases was not an avoidable transfer because the termination
was not a “transfer” as defined by law. 3 Instead the Bankruptcy Code deals separately with the effect of terminated
leases in Section 365(c) which provides that “the trustee may not assume or assign any … unexpired lease of the debtor
… if … such lease is of nonresidential real property and has been terminated under applicable non-bankruptcy law prior
to the order for relief.” 4
On direct appeal, the Court disagreed with the legal conclusion that a termination of lease is not a transfer, explaining
that the Bankruptcy Code, in section 101(54)(D), defines “transfer” broadly, to include the parting with an interest in
property. 5 Here, the Debtor had an interest in property—the leaseholds—which it parted with by transferring the
interest to the Landlord. 6 Thus, if the Debtor received less than equivalent value for the surrendered leases or if the
Landlord received more as a result of the surrender than it would have received had the leases been part of the
bankruptcy estate, than the transfer was fraudulent or preferential. However, those value questions required factual
findings by the Bankruptcy Court.
Accordingly, the Court reversed and remanded the case to the Bankruptcy Court for it to determine the value of the
transfer and, thus, determine whether the transfer could be avoided as preferential or fraudulent. 7
Conclusions
The Court’s decision in Quick Lube is a departure from prior cases that have held that the termination of a lease does not
constitute a transfer subject to avoidance in bankruptcy. In determining whether to terminate a lease with a distressed
tenant, Landlords should consider the impact of Quick Lube and the possibility that they will have exposure for the
value of lease in a subsequent bankruptcy of the tenant.
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This alert provides a general summary of recent legal developments. It is not intended to be and should not be relied upon as legal advice. In some
jurisdictions, this may be considered “Attorney Advertising.”
1
Official Committee of Unsecured Creditors of Great Lakes Quick Lube LP v. T.D. Investments I, LLP (In re Great Lakes Quick
Lube LP), Case No. 15-2093 (7th Cir. Mar. 11, 2016).
2
11 U.S.C. §547(b).
3
Quick Lube, Case No. 15-2093 at 2.
4
11 U.S.C. §365(c)(3).
5
Quick Lube, Case No. 15-2093 at 5. In doing so, the Court rejected the Landlord’s argument that section 365(c)(3) applied. Id. at
5-6. The Court held that the section did not apply because the Committee was not seeking to assume or assign the leases, but rather
was seeking to avoid the transfer and recover value for the bankruptcy estate. Id. at 6-7.
6
Id. at 5. The Court drew the important distinction between the value of the leases (value to which the creditors may be entitled) and
the leases themselves (which could not lawfully be transferred to them), explaining that the Committee could not seek to evict the
current tenants but could recover from the Landlord the value of the terminated leases.
7
Id. at 7.
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